Why the markets are wrong to ignore Powell on rates

Thankfully, Deutsche Bank’s chief US economist Matthew Luzzetti nailed it when he said caution must be exercised when markets carry on like this.

“I would certainly agree with chair Powell today that you don’t want to over-emphasize any short-term movements, you especially don’t want to over-emphasize movements around a key event risk as what we’ve had with today’s Fed meeting.”

A fairly lone voice, Luzzetti said sensible, rational investors should wait for more inflation data before diving in, suggesting such data would see interest rate pricing markets drift more inline with the Fed’s view of peak rates.

“It could very well come simply from the pricing and that the Federal Reserve expects the terminal rate to be above 5 per cent.”

One of the key differences is that many in the market think inflation will fall faster than the Fed thinks. Powell addressed the discrepancy in his press conference.

“There’s a difference in perspective, by some market measures, on how fast inflation will come down. We’re just going to have to see, I mean, I’m not going to try to persuade people to have a different forecast,” Powell said.

“But our forecast is that it will take some time and some patience and that we will need to keep rates higher, for longer, but we’ll see…we’ll see,” he said.

Powell’s overall tone was pretty up beat, so the direction, but maybe not so much the magnitude, of the market reaction was warranted.

“I continue to think that there’s a path to getting inflation back down to 2 percent without a really significant economic decline or a significant increase in unemployment,” Powell said.

He then listed a host of other reasons to be positive.

“There are other factors, although that need to be considered… you will have seen that the global picture is improving a bit.

“The labor market remains very, very strong and there is job creation.

“You also see state and local governments are really flush these days with money, and many of them are considering tax cuts or even sending checks.”

“There’s a lot of spending coming in the construction pipeline, both private and public. And so, that’s going to support economic activity.”

“So I think there’s a good chance that those factors will help support positive growth this year. And that’s my base case is that there will be positive growth this year.”

But with more growth comes more inflation, and that means the Fed will want to keep even more vigilant on interest rates.

How markets can be so confident in the Fed not raising rates above 5 per cent this year really has to come down to guesswork and a bit of irrational exuberance.